Second mortgages complicate efforts to help homeowners

As government regulators and lenders work to stabilize the housing market, one of the factors that helped propel the housing boom of the past decade is now taking a central role in thwarting their efforts: second mortgages.

Programs to help distressed borrowers so far have focused on lowering the payments on their primary mortgage. But during the go-go years of the housing market, millions of homeowners took out a second or even third loan backed by their home. Many were piggyback mortgages, which enabled home buyers to put little or no money down, while others took advantage of rising home prices to secure home-equity lines of credits.

Now, these secondary loans are aggravating the foreclosure crisis, adding an extra burden that can be the difference between borrowers digging out of debt and losing their home. The extra mortgages also make it far more unwieldy for lenders to untie the knot of excessive debt and provide relief to borrowers. And even when borrowers do get help with their primary mortgages, the second loans can continue to bedevil homeowners, raising the risk they will default later.

A new effort

The Obama administration is about to ramp up its efforts to tackle second mortgages as part of an aggressive program announced by the White House on Friday to address foreclosures. Other steps include a requirement that lenders offer temporary mortgage relief to unemployed borrowers and increased incentives for lenders to cut loan balances for borrowers who owe more than their homes are worth.

Government officials have estimated that about 50 percent of troubled borrowers have a second mortgage. But a year after federal officials launched an initial program to lower payments on these second loans, not a single homeowner has been helped. The efforts have been hamstrung by technical challenges, the competing interests of the banks that hold the first and second mortgages and a reluctance among some major financial firms to take heavier losses, according to economists and housing analysts.

As part of the new program, the government will double the amount of money it can pay lenders to forgive part of a borrower's second loan or wipe it out altogether. Administration officials say many of these mortgages would be worthless if borrowers were forced into foreclosure, so it is in the lenders' interest to settle for less than full repayment.

The problem posed by second mortgages has even prompted Blackrock, a huge asset-management firm that manages billions of dollars in first-lien mortgages, to lobby lawmakers with a plan that would allow bankruptcy judges to modify troubled borrowers' debts, including home loans. That puts Blackrock at odds with much of the financial services industry, which last year helped kill a similar proposal in the Senate.

But Blackrock argues that bankruptcy courts working with new guidelines could take into account all of borrowers' debts, in contrast with most loan-modification programs, which address only primary mortgages.

The debt burden

The shortcomings of the current approach are exemplified in the government's marquee foreclosure-prevention initiative, known as Making Home Affordable. Under that program, lenders are paid to lower borrowers' primary-mortgage payments to 31 percent of their income. But even after this relief, borrowers still spend on average 60 percent of their income on their debts overall, including their second mortgages, credit cards and car payments, according to Treasury Department data.

That is the challenge facing Sarah Ferrell. She spent six months securing a loan modification for her Phoenix home, lowering the payments to about $700 a month from $1,200. But she owes another $300 a month on her second mortgage, a home-equity loan. Ferrell said she still can barely break even each month and will continue to use credit cards for some essentials. "It was really a blessing to get this help, but it didn't fix everything," she said.

And down the road, difficulties could mount further for homeowners like Ferrell. After five years, the interest rate on mortgages modified under the federal program begins to rise.